ABC just issued US$200 million 10 year bond at PAR with an annual coupon of 2% attached with a 3-year warrant on ABC shares. Each bond has a US$10,000 denomination and has 500 detachable warrants. 1 warrant allows bondholder to purchase one ABC share at an exercise price of US52. Currently, the ABC share is quoted at US$40 and the Yield to Maturity (YTM) of a similar fixed coupon bond issued by ABC is 4%. (a) If the market has a standard that if a warrant has a premium greater than 20%, the warrant is then expensive. Given the issuance terms, would you recommend investors to buy this issue? (Hint: Calculate the $ value per warrant to evaluate the warrant premium in %). (b) At the same time as (a), ABC also issued a Convertible Bond (CB) with a zero-coupon with a Conversion Price that gives the Conversion Premium the same Warrant Premium as Bond + Warrant in (a). If investors have an extremely bullish view on ABC over the next 10 years, what would you recommend to investors between this CB and the “Bond with Warrants” described in (a). Explain the rationale between your recommendation.

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
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ABC just issued US$200 million 10 year bond at PAR with an annual coupon of 2% attached with a 3-year warrant on ABC shares. Each bond has a US$10,000 denomination and has 500 detachable warrants. 1 warrant allows bondholder to purchase one ABC share at an exercise price of US52. Currently, the ABC share is quoted at US$40 and the Yield to Maturity (YTM) of a similar fixed coupon bond issued by ABC is 4%. (a) If the market has a standard that if a warrant has a premium greater than 20%, the warrant is then expensive. Given the issuance terms, would you recommend investors to buy this issue? (Hint: Calculate the $ value per warrant to evaluate the warrant premium in %). (b) At the same time as (a), ABC also issued a Convertible Bond (CB) with a zero-coupon with a Conversion Price that gives the Conversion Premium the same Warrant Premium as Bond + Warrant in (a). If investors have an extremely bullish view on ABC over the next 10 years, what would you recommend to investors between this CB and the “Bond with Warrants” described in (a). Explain the rationale between your recommendation.
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